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Quick question on writing puts.
Let's say stock X currently trades at $100. Let's say you write 2X $90 contracts for $2.75 (say). Then I understand upfront one would receive a credit of $550.
Now, what I'm not quite sure on is the following:
If the stock goes to say $90 and gets exercised then would we end up purchasing the 100 shares, is this done at $90 (i.e. we lose $90 X 100 shares = $9,000), OR is it done at $10 differential X 100 shares (i.e. $1,000 loss)?
Options are always executed at the strike price. Since the strike of your hypothetical option is $90, that's what you'd buy the stock for. The price of the stock at the time the option was written is irrelevant.
Note that you wouldn't necessarily lose $9,000 - you'd buy the stock for $90 and could turn around and sell them for $90 (the current market price) , so there's no profit or loss. Overall, in fact, you've gained $550 due to the premium you received upfront.
Where you would lose is if the stock went below $90. Say the stock was at $80 at expiry. You'd be forced to buy them at $90 but they'd only be worth $80, so you have a paper loss of $10 per share. You could keep them and hope they come back, or sell them and lock in the loss (preventing further losses). Your "break-even" price in that scenario would be $87.25 - the $90 you'd be forced to buy the stock for less the $2.75 you received in premium upfront.
A short put means that you have the obligation to purchase the underlying at the strike price of the contract or $90 in your example. If assigned, your cost basis is $90 less the premium received ($2.75) or $87.25
If the purpose of selling the put is to acquire the stock at $87.25 then there's nothing to do. Either the put expires and you keep $2.75 or you are assigned and you acquire your position.
If you are selling premium for the sake of premium, then if the stock drops and heads toward $90, you can adjust the position and roll the short put down and possibly out in time. It's good practice to sell time for intrinsic value and note that it should be done before the option gets a fair amount in-the-money.
For example, XYZ approaches $90 some time from now. You've achieved a fair amount of time decay but premium has increased due to share price drop. Suppose your short put now trades for $3.50. Let's say that you can roll your short put down to $87.50 for at least break even. Now, your assignment price is $87.50 and your cost basis if assigned will be $84.75. Try to stay ahead of the tsunami (note the 35% market drop in March).
Use combo orders to roll options so that you can reduce slippage. IOW, place a vertical spread order to Buy To Close your current short $90 put and to Sell To Open the $87.50 put.
If your are indeed selling short puts for the sake of the premium rather than a desire to own the stock, consider selling credit spreads rather than short puts. This is an unforgiving market and owning some risk mitigation tends to be a wise decision.
